Thursday, 19 March 2015

Help-to-Buy ISAs will end up feathering nests of the wealthy

Posted by Christian Hilber, SERC and LSE

George Osborne’s bid to boost home ownership in Britain might look
like an effort to give young people a leg-up onto the housing ladder,
but the evidence suggests they will be sorely disappointed. The Chancellor of the Exchequer’s budget
unveiled a new “Help-to-Buy ISA” savings account which will subsidise
deposits for first-time buyers while leaving untouched the fundamental
flaws at the heart of our growing housing crisis.

The new ISA savings accounts
will be available through banks and building societies from this
autumn. In a nutshell, the government will add £50 to every £200 which
savers manage to put away towards the deposit. First time buyers can
make an initial deposit of up to £1,000 when opening the account. The
total subsidy to first time buyers is capped at £3,000. It can be used
by first time buyers to purchase homes priced up to £450,000 in London
and £250,000 elsewhere.

The new policy is similar in spirit to the various predecessor Help-to-Buy schemes.
The Help-to-Buy policy has been described by commentators as the
biggest government intervention in the housing market since the Right-to-Buy scheme of the 1980s.
But Help-to-Buy and, in particular, the new Help-to-Buy ISA are not a
good idea. They are unlikely to help first time buyers achieve their
dream of home ownership.

Why it won’t work

The new ISA is intended to stimulate housing demand from first time
buyers. This should translate – in theory at least – into new housing
being supplied and higher home ownership.

However, evidence from the US suggests that there is only a very weak link at best
between housing subsidies and improved home ownership levels. In fact,
in tightly regulated housing markets in the US (where there is
inflexible supply), the subsidies have a negative effect on home
ownership because the price effect – through increased demand – more
than offsets the income effect from the subsidy. In less regulated US
markets (with flexible supply), subsidies do have a positive effect on
home-ownership rates, but only for higher income groups.

The trouble, from the UK perspective, is that long standing evidence that I have recently considered in research with Wouter Vermeulen
suggests that the UK has an extraordinarily inflexible planning system.
This makes housing supply incredibly unresponsive to demand shocks and
acts to push up house prices. This effect is most pronounced for London
and the South East, where planning regulations are tightest. In other
words, stimulation of demand by a Help-to-Buy ISA has the likely effect
of driving up house prices, especially in London and the South East,
while having no positive effect on construction or ownership.

A busted building boom

Consistent with this idea, according to Nationwide,
house prices in London increased by 25.8% in the year following the
announcement and subsequent implementation of the original Help-to-Buy
scheme, from the second quarter of 2013 to the same period in 2014.

A residential building boom failed to emerge. To the contrary, housing construction is currently at record lows. According to statistics from the Department for Communities and Local Government,
the UK built close to 380,000 new homes in the fiscal year of 1969/70
(when statistics began). Housing construction gradually declined towards
a record low in 2012-13 of less than 135,510 new homes. In 2013-14
figures were slightly higher at 140,930 new homes, but this reflects the
typical increase associated with an economic recovery rather than a
building boom induced by Help-to-Buy. The UK homeownership rate has been
in decline since the turn of the millennium, falling from 69% in 2001 to 64% in 2014.

With all likelihood the Help-to-Buy ISA scheme will have similar – if
perhaps weaker – stimulating effects on housing demand and prices. The
positive effect on house prices may be particularly pronounced in London
and the south east and for starter homes. However, it is important to
note that since starter homes, “trade-up” homes and private rental homes
are all reasonably close substitutes, house prices and private rents
are likely to increase across the spectrum.

No Spain, no gain

In fact research by François Ortalo-Magné and Sven Rady
for both the UK and the US suggests that due to “trickle-up effects”,
capital gains on starter homes incurred by credit-constrained owners can
lead to a housing price overreaction, with prices of trade-up homes
displaying the most volatility. As a consequence of all this, it is
highly likely that first time buyers are no better off. In fact they may
be worse off for two reasons. First, as tax payers they help finance
the subsidies. Second, the increased prices of starter homes may mean
that first time buyers can no longer reach the loan-to-income ratios recommended by the Bank of England and thus are priced out.

So who benefits from housing subsidies such as the Help-to-Buy ISA?
Almost certainly it is not young first-time buyers, or even younger
existing homeowners who will find trade-up homes for expanding families
are further out of reach. Instead, because the subsidy likely increases
house prices and private rents across the housing spectrum, the main
winners may in fact be wealthy buy-to-let owners and older homeowners,
especially those thinking about downsizing or moving to countries where
housing is comparably affordable. In short, the policy may in fact
subsidise wealthy owners of multiple or expensive properties and
retirees who sell-up for a move to Spain.

Any political party that is serious about solving the British housing
crisis should address the rout-cause of the problem, which is the
broken British planning system. The proposed Help-to-Buy ISA not only is
likely ineffective in raising home ownership, it also likely has
undesirable redistributive effects, and, perhaps worst of all, worsens
the ongoing housing affordability crisis.

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